Monday, 18 March 2013

Cyprus Bailout: Welcome To Another Great Depression

Tim Worstall, Contributor
So, this is going to be a very sour reading of what has happened in Cyprus this weekend. It will also be a very partisan one, possibly even a partial one. But if Milton Friedman and Anna Schwartz were right in their insistence that it was actually the Federal Reserve that caused the Great Depression (which is something that Ben Bernanke himself has insisted that the Fed will not repeat) then one way of interpreting what has happened is that the European Central Bank has just set us all up for another Depression. The trigger is that “tax” of a little over 6% on all depositors.
This isn’t an analysis that you’ll be able to get all economists to sign up to. But the basic story told by Friedman and Schwartz in “A Monetary History of theUnited States” was that the 1929 crash was indeed a serious crash. But it would not have led to the Great Depression without the Federal Reserve making some serious mistakes. Two of which were to allow the intertwined collapses of both the money supply and the banking system. Given that it is the banks that create credit and thus the wider money supply they are, to a great extent, the same thing.
The actual process was the series of bank runs that happened through the early 1930s. The problem is that in a fractional reserve banking system banks are inherently unstable. The fractional refers to the fact that when you deposit $100 with one they don’t then keep that $100 in the safe. They take a guess at how much they need in the safe (OK, it’s an informed guess, but it is a guess) for when people turn up demanding their cash and the rest of it they lend out to other people. This is how companies, mortgages and business loans are financed (please, we don’t need to go into “ but loans finance deposits” and all that: it might even be true but it’s irrelevant here).

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